Page 1 of 3 Most retail investors use an investment dealer or broker to make their investments. Any investor who uses an intermediary must realize that the collapse (very unlikely but not impossible) of their financial intermediary may, depending on the circumstances and the availability and terms of the industry protection fund, expose you to serious financial loss. In the last commentary in a 3 part series on this subject we will now look at what preventive steps investors can take to minimize intermediary insolvency risk.
Introduction
In the first commentary in this series we looked
at the existing dealer bankruptcy protection regime and some common
misconceptions about how you are protected. In part 2 we looked at which
types of investors should be most concerned by the risk of dealer bankruptcy.
We now complete the picture by looking at available preventive steps to
minimize intermediary insolvency risk. These fall into 4 broad categories:
- Change how your investments are held to minimize
dealer bankruptcy risk
- Accept dealer bankruptcy risk, but seek to maximize
CIPF coverage
- Minimize financial intermediation through DRS
- Use financial intermediaries that are not
securities firms
We will now look at each.
Change
how your investments are held on your behalf
Part 12 of Canadian Bankruptcy and Insolvency
Act
(BIA) provides that the assets of all customers
generally fall into a single, common pool, and the rights of the customers
become financial claims to be dealt with uniformly by the trustee. The
practical result? If there is a
deficiency (i.e. there are not enough assets to satisfy all customer claims)
the customers will not be fully paid in the bankruptcy, but become dependent on
the CIPF fund to make up the deficiency.
The BIA (s.253) does however have an
exception for so-called customer name securities:
“customer
name securities”
means securities that on the date of bankruptcy of a securities firm are held
by or on behalf of the securities firm for the account of a customer and are
registered or recorded in the appropriate manner in the name of the customer or
are in the process of being so registered or recorded, but does not include
securities registered or recorded in the appropriate manner in the name of the
customer that, by endorsement or otherwise, are negotiable by the securities
firm;
For these types of securities, the BIA
(s.263) in effect treats these securities as the property of the customer, and
directs that the trustee shall deliver to
the customer the customer name securities, net of any indebtedness of the
customer to the firm.
Therefore, customers have an incentive to
seek to have their investments qualify as customer name securities, and in
effect stay outside of the financial intermediary bankruptcy process. The key
requirement is that the investments be registered
or recorded in the appropriate manner in the name of the customer… but does not include securities registered
or recorded in the appropriate manner in the name of the customer that, by
endorsement or otherwise, are negotiable by the securities firm.
In the normal course customer investments are
held in street name (see Wikipedia), not registered in the name of the
customer (or if so registered, are endorsed in blank in favor of the dealer),
and do not qualify as customer name securities. The customer would need to
specifically request that his bond and share investments be registered in his
(her) name and that the dealer continue to hold them on behalf of the customer;
thereafter they would constitute customer
name securities. Faced with such a request a dealer will be reluctant to
change how they hold client securities. The dealer may take any of a number of
actions, including:
- Best case (but in our view unlikely) - agree to
the request altogether
- Worse case-refuse altogether (in our view the
likely response)
- Accept to do so, but insist that the client
sign some sort of separate safekeeping agreement to govern the holding of the
securities (and probably pay ongoing fees to the dealer).
- Accept to re-register the securities, but
then decline to continue holding the investments for the customer (in which
event the customer may have to take responsibility for physically holding them,
not necessarily an interesting task
- Refuse to do so, but offer to assist the
client (probably for a small fee) in registering the securities under the DRS
system, which we discuss below,
If any of our readers have
experience or have had discussions with their investment dealer on this point
which they are prepared to share with us, please contact us.
GIC’s are a special case, which we discussed
in the second commentary in this series. CIPF, in its correspondence with
us PDF doc.2150, states:
- In general customer-name
securities are in non-negotiable form and the customer would have to provide a
power of attorney to the Member in order for it to sell the security on the
customer's behalf. The practice of holding securities in customer name in
safekeeping at a Member firm will vary. You are right that the costs of
administering customer name securities makes it uncommon. Its likely that
if the customer wants to hold a GIC in client name that the dealer member would
deliver the certificate to the customer upon completion of purchase (rather
than hold it in safekeeping). You would probably be best to direct your
question regarding administrative implications of holding customer name
securities to a Dealer Member.
What we conclude from the
above is that is neither easy nor customary to arrange your affairs so that
your GIC’s bought through an investment dealer are held by the dealer in a way
that qualifies them as customer-name
securities. This is obviously a disappointing conclusion for investors who
buy GIC’s specifically because they want to qualify for a government guarantee
if things go wrong AND also wish to use their dealer to hold them on their
behalf. If any of our readers have experience or have had discussions with
their investment dealer on this point which they are prepared to share with us,
please contact us.
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